May 5, 2021 - by Ted Basta. The secondary loan market returned to its rallying ways in April after taking something of a breather in March. The S&P/LSTA Leveraged Loan Index (LLI) returned 0.51% in April after running ever so slightly in the red (-0.0025%) the month prior – the market’s first “negative” reading in 12 months. While YTD loan returns still lead the fixed income markets at an impressive 2.3%, the high-yield bond market narrowed that lead to just 29 basis points following a very strong April showing (+1.1%). Unsurprisingly, both the loan and high-yield bond markets continue to outperform the more rate-sensitive and lower yielding high-grade bond and 10-year treasury markets, where YTD returns remain in negative territory at -3.4% and -6%, respectively.
Back to the secondary loan market where bid levels increased 24 basis points in April, to an average of 97.8, the highest reading since November 2018. Today’s average bid level is 160 bps stronger on the year and more than 100 bps higher than February 2020’s pre-pandemic level. Market breadth reversed course in April as the secondary’s advancer/decliner ratio improved to approximately 2:1, where 60% of loan prices advanced and 29% declined. This was a complete reversal from March where 71% of prices declined and just 20% advanced. And as most of the secondary traded higher in April, the average bid-ask spread tightened another eight basis points to fall below 80 basis points – the first time since late 2018.
Once again, the high-beta/yield-rich side of the secondary outperformed in April with CCC rated loans (8% of outstandings) returning 1.3%. Single-B (60% of outstandings) and double-B rated loans (20% of outstandings) produced lower returns, at 0.5% and 0.28% respectively. According to the LLI, the CCC sub-index has rallied for 13 consecutive months, gaining 46% during this period after losing 22% during the March 2020 sell-off. Risk aversion has clearly dissipated as investor demand for higher yielding paper has intensified alongside a meaningful strengthening in credit metrics. First, according to the LLI, the trailing 12-month default rate (by amount) fell another 55 bps in April to a thirteen-month low of 2.61%, after hitting a post-pandemic high of 4.2% during September. Second, the three-month trailing downgrade-to-upgrade ratio has remained below 1:1 since February (signifying that there were fewer downgrades than upgrades). And alongside stronger credit conditions, visible flows into the asset class remained robust in April. The 2021 CLO market has already produced a record $51.6B in new issuance, after pricing almost $13B in April. At the same time, after two years of negative flows, loan mutual funds and ETFs are once again attracting the attention (and dollars) of regular way investors who are seeking out floating rate investments. Inflows have now totaled almost $19B this year, after tallying an impressive $5.7B in April, according to Refinitiv. Quite the change from 2019 and 2020, where redemptions totaled a staggering $47B. Loan Mutual Fund AUM is now approaching $113B, marking the first time since February 2020, when AUM has surpassed $110B.
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